Streaming Music: Give It Away, Give It Away, Give It Away Now [Glenn Peoples Of Pandora]

Here Glenn Peoples of Pandora explores the differences in royalty payouts between services which offer highly interactive on-demand streaming versus those that provide a more basic digital radio option, and how these differences impact the modern music industry as a whole.

____________________________

By Glenn Peoples, Music Insights and Analytics at Pandora

Key takeaways:

The music industry will underperform as long as some services aren’t paying a premium for premium features.

On-demand services typically — but not always — pay to rights holders a premium over what they pay for digital radio. This premium is the amount paid for a step-up in features and interactivity.

Some free, on-demand services pay royalties that are roughly the same or less, according to published reports, than the statutory rate paid by free digital radio services with fewer features and no on-demand capabilities.

Want to stream “Closer” by The Chainsmokers? Or listen to songs on dozens of “chill” playlists? Itching to hear “Don’t Stop Believin’” right here and now? You’ll have to pay for those privileges. Or not.

Generally, a listener has two options in music streaming: on-demand and (usually free) digital radio. More features versus fewer features. More control over the listening experience versus less control. A higher price versus a lower price (or no price). Interactive rights command a premium over digital radio rights. That is to say, the features offered by an on-demand streaming service have more value — to both rights holders and users — than the features of an Internet radio service.

Features dictate services’ prices — sometimes. Licensing terms demanded by rights holders are firm and exacting — sometimes. An on-demand service typically charges users $9.99 per month (exceptions include family plans and student discounts). But there are instances in which an on-demand service doesn’t pay this premium and doesn’t pass along the cost of this premium to its users. When this happens the market gets warped, rights holders don’t get market-rate royalties and the industry underperforms.

As the saying goes, “Why buy a cow when you can get the milk for free?” Differential pricing allows rights holders and services to separate consumers according to their willingness to pay. Some consumers will pay the standard rate for the full-feature premium product. But when given the option, far more consumers will pay nothing the same or nearly the same features. Ultimately the industry will underperform if premium features don’t result in premium royalties.

It helps to better understand the two main classes of music streaming models, on-demand and non-interactive. On-demand services cost more to license because they provide more control over the listening experience. A listener can skip an unlimited number of times and instantly play any song or artist. Next month Pandora will unveil an on-demand service, Pandora Premium, with these features that command standard licensing costs and result in standard pricing for the user. [Click here for a helpful infographic that walks the reader through the flow of money for on-demand licenses.]

At the other side of the spectrum are the non-interactive services, such as Pandora’s free service. They provide less control over the listening experience. Skips are limited. A listener is served songs based on an artist or song but can’t instantly listen to a particular artist or song. With these non-interactive features come licensing costs that are lower than on-demand listening costs.

In the middle is the free, on-demand services with per-spin royalties equal or lower than non-interactive services. This is where Spotify and YouTube reside. They play music on-demand and have other on-demand features. They act like premium services but are free to the user and ad-supported.

It’s ironic on-demand services are called premium services. Premium, on-demand services must literally pay rights holders a premium for interactive features. (To be clear, the term premium refers to the value to consumers and is not a commentary on licensing costs.) This premium is the difference between the on-demand royalty rate and the non-interactive royalty rate. It’s the step-up in value from the “lean back” listening experience to the “lean in,” more hands-on experience.

There’s an order to the pricing of streaming services. Like any business, the music business has segments of consumers with varying willingness to pay. Charge the highest price for the group that wants the most features. Charge less for another group and give them fewer features. And charge even less—or nothing—for the group that’s OK with even fewer features.

Some people are attracted to a paid, on-demand services with the bells and whistles desired by heavy users. (These are potential subscribers to Pandora Premium.) Subscribers pay a premium for the ability to “lean in” and enjoy a hands-on experience with a large catalog of music. Some of the on-demand features are the ability to play any song desired, build playlists, download songs to devices, and skip songs an unlimited number of times.

Others consumers subscribe to a mid-tier product like Pandora Plus, which eliminates advertisements and has an innovative feature that automatically downloads four channels to the subscriber’s device. Finally, listeners unwilling to pay opt for a free, non-interactive service — the standard Pandora Radio product — that provides personalized radio without premium or mid-tier features.

The premium plays an important role in today’s music business. Rights holders collect the premium and pass a share to recording artists, songwriters and composers. Performing rights organizations collect part of the premium on behalf of songwriters and composers. Streaming royalties now make up nearly half of all recorded music revenues in the U.S. An exception to the rule, of course, arises when a premium isn’t captured because a service provides on-demand features for free.

Understanding the different royalties will better explain the size of this premium. A free, non-interactive currently pays 0.17 cents per stream (that’s $0.0017), an amount set by the Copyright Royalty Board in December. Section 114 of the Copyright Act grants this royalty to a compliant non-interactive service without the need of a direct licenses from record labels. A Section 114-compliant service must abide by rules that limit interactivity. For example, one rule limits the listener to three songs from the same album within a 3-hour period. It also prevents a service from revealing upcoming songs or the performing artist except in limited circumstances.

But on-demand services aren’t compliant with Section 114. Going from a “lean back” business model to a “lean in” model means higher costs associated with the added features. On-demand services pay record labels roughly 57 percent of revenue collectively (another 12 or 13 percent is allotted for the composition). In the most simplistic terms — it’s far more complicated — that pool of money is distributed on a pro-rata basis according to an artist’s spins. A comfortable range of average payouts to record labels is 0.6 cents to 1.2 cent per stream from the more popular services, according to published reports.

As for free, on-demand services, mediareports put Spotify’s and YouTube’s per-stream royalty in the range of 0.10 to 0.17 cents per stream. (As discussed below, Pandora pays about 0.17 cents per stream for its free service.) On a per capita basis, YouTube paid music creators “less than $1” in 2015, according a recent letter from U.S. trade bodies that encouraged the U.S. ambassador to the European Union to support reforms they believe will address this disparity in royalties. This type of service has many of the features desired by consumers but none of the costs — and royalties for that matter — associated with the on-demand premium.

So, a non-interactive service wishing to add an on-demand tier would need to pay a premium anywhere from roughly 0.4 cents to over 1 cent per spin depending on the service. Based on those figures, “lean in” on-demand services pay a premium 300 percent to 490 percent more than “lean back” non-interactive services.

The difference between the free business models can also be seen in industry-wide revenue figures. According to the RIAA’s 2016 mid-year report, ad-supported on-demand streaming produced $195.4 million in royalties paid to record labels. During that same period Pandora alone paid record labels roughly $290 million — 48 percent more than all free, on-demand companies put together. So, in spite of their popularity, ad-supported on-demand services aren’t producing royalties commensurate with their share of streaming.

Digital distribution has been lauded for leveling the playing field, allowing both hobbyists and superstars to distribute their music to download and streaming services. Licensing terms also leveled the playing field — mostly. For the marketplace to work efficiently one service should license music under roughly the same terms as other services. That puts services on equal footing for royalty costs. When an on-demand service gets a new user, royalty costs rise a predictable and equitable amount. Services don’t end up competing on price. They compete by making better products.

If the industry’s goal is to build music revenue — sustainable revenue from sustainable business models — listening hours at standard-royalty services can’t be siphoned off to services paying a less-than-a-standard-royalty rate. To get premium features consumers should buy the cow rather than get the milk for free.